Commission or flat fee? How to pay your broker

Some brokerages now offer investors a money-saving choice

Take care with margin costs

On The money

Your Money

April 11, 2004|By Lorene Yue

Stock trading has become a commodity, which has forced brokerages to find new ways to make money. That means investors have to make sure they are not adding to their broker's bottom line while subtracting from their own.

"The profit margins are razor thin," said Frank Fernandez, director of research for the Securities Industry Association. "We've had three years of revenue declines in the industry. Even though profits are up, it's all been through cost cutting."

Stiff competition among brokerages led to a flurry of discount prices in recent years to snag your business. It may have kept people trading, but it wasn't making the brokers any money.

"That kind of frenzy has leveled off," Fernandez said. "Firms have stopped pricing things as a loss leader."

The latest trend is toward a flat-fee service charge instead of charging a commission per transaction. Fee-based firms typically take 1 percent to 2 percent of total assets under management as payment for their services, and the broker makes money even if the customer rarely buys and sells stock.

So an investor has some real choices to make. Some places now offer only a flat-fee structure, while others give you a choice between flat-fee or commission.

"The idea is that one size does not fit all," said Dan Deegan, national sales manager for Banc One Securities in Columbus, Ohio. The investment firm, one of the largest in the nation in terms of locations, last year began offering a flat fee for stock services in addition to commission.

Long vs. short term

Ask yourself a few questions about your investment habits to determine which is the best approach for you.

If you are truly a long-term investor with a buy-and-hold strategy, you are better off paying commissions.

"If you have someone doing moderate to high levels of trading, a fee-based account makes sense," said Jim Eccleston, a Chicago securities lawyer. "If you are buying and holding, you shouldn't be paying fee-based, you should be paying a commission."

If you don't do much trading in your account, you could be overpaying in a flat-fee situation. And don't count on your investment firm to tell you so.

The National Association of Securities Dealers recognizes that keeping customers informed of choices is a matter of ethics. In a recent notice, the association "reminds members that they must have reasonable grounds for believing that a fee-based program is appropriate for a particular customer, taking into account the services provided, cost and customer preferences."

"If you have a large and inactive account worth $100,000, a fee could be $1,000," said Marc Menchel, general counsel for NASD. "If you are only doing four or five trades a year, you are not going to have $1,000 in commission fees."

It's also a good idea to review your service charges at least once a year to make sure you are in the best payment plan.

Margin costs

Watch out for margin costs. The uptick in margin loans, when your brokerage lends you money to buy stocks, has created a downside to both commission and flat-fee service charges. Margin investing shot up 25 percent in the first nine months of last year, according to NASD figures.

Brokerages may promote margin loans if they are being paid on a commission because, if you take them up on it, you will be paying a fee for the stock purchase. And if you are paying a flat fee, your loan could be counted as part of your total assets, which means you will pay extra.

"If you give your broker $100,000 to invest and you are charged a flat fee of 2 percent a year, then you take out a $50,000 margin loan to buy more stocks, you'll end up paying a fee on $150,000," Eccleston said.

Lorene Yue is a Your Money staff writer.

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